Important disclosures can be found in the disclaimer

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Interest Rate Barometer

Executive Summary The interest rate barometer considers the factors influencing the decision

of the SARB’s Monetary Policy Committee in the statement accompanying

the previous meeting’s interest rate decision (17/07/2014) as well as

developments since the previous meeting which could influence Thursday’s

MPC rate decision. The factors are rated as a likely hike, hold or cut and are

weighted into 3 broad categories: global economy (20%), domestic

economy (40%) and major inflation drivers (40%) as per Table 1.

Of the 13 factors analysed above, 8 support expectations for an unchanged

policy, 3 favours a rate cut, while 2 factors favour a rate hike (see Table 2).

Using the weightings, there is 63% bias for rates to be unchanged, a 20%

bias for rates to be cut, and a 17% bias for rates to be hiked.

Nedbank’s view is for rates to remain steady at this week’s MPC meeting,

after the 25 basis point hike in July. Inflation has moderated since our last

Interest Rate Barometer, but growth still remains benign, leading to

expectations for no move this week.

The SARB could consider a hike of 25 basis points at the November policy

meeting, but this remains largely dependent on the inflation trajectory and

the rand. However, the probability of the SARB pushing out the hiking cycle

has risen, given the current weak growth outlook.

Table 1

Factors Outlook at July policy meeting Recent developments Rate impact

GLOBAL

ECONOMY (20%)

Growth “The global economy continues to exhibit mixed signals regarding the economic growth outlook. Since the previous meeting, consensus forecasts for growth in 2014 have been revised down for the US and the Eurozone, but those for Japan and the UK have been revised upwards. The outlook for emerging markets remains relatively subdued, but some emerging Asian economies have benefited from stronger US growth. Subdued growth is expected in a number of emerging markets including Brazil, Russia, Thailand and Argentina.”

The IMF cut its global growth forecast to 3.4% for 2014 from 3.7% as a result of lower growth expected from advanced economies. The IMF’s view on the US continued to deteriorate with a downward revision from 2.8% to 1.7%. The Eurozone was expected to grow at 1.1% this year, unchanged since previous, while the 2015 outlook has been raised by 0.1% to 1.5%. Emerging market economies as a collective were downgraded to 4.6% from 4.8% previously with tightening financial conditions highlighted as a headwind.

HOLD

Inflation and interest rates

“By contrast to a number of emerging market economies, inflation remains benign in the advanced economies, although the risk of deflation in the Eurozone persists. The UK is expected to be the first advanced economy to raise interest rates, but at a moderate pace, while the US is generally not expected to begin the process of normalisation before the third quarter of 2015.”

Inflation in the developed world remains subdued, while emerging markets have been battling price pressures. Recently, the Fed and the BOE have seen increased debate for an earlier than expected rate hike, with two members voting for a hike at the August BOE meeting, but much slack still remains in the respective labour markets, which will need to be reduced to accommodate higher rates. Monetary policy remains mixed in emerging markets.

HOLD

Oil price “Despite recent geopolitical risks, particularly in the Ukraine and Iraq, international oil prices have remained relatively stable. Following the appreciation of the rand in April, the petrol price was reduced by a total of 37 cents per litre in May and June, but this was largely reversed in July when the price increased by 31 cents per litre. Should current trends persist; a further small increase in the petrol price can be expected in August.”

Oil prices have declined by 8.6% since the last MPC meeting in July, and traded within a $96/bbl - $109/bbl range. The EIA has cited rising supplies from the US and Libya as the main reason the market remains well-supplied, while demand forecasts have been downwardly revised due to a slowdown in China.

CUT

DOMESTIC ECONOMY (40%)

SARB’s GDP forecast

“The economic growth outlook has deteriorated against the backdrop of protracted strike action in the mining and manufacturing sectors and the outlook remains subdued. The Bank’s forecast for GDP was downwardly revised to 1.7% for 2014 (previously 2.1%) and 2.9% in 2015 (previously 3.1%).”

SA real GDP growth rose to 0.6% q/q in 2014/Q2, from a contraction of 0.6% in the first quarter. The weak GDP print was mainly the result of a larger than expected decline in mining and manufacturing output, which subtracted 0.4% and 0.3% from the headline figure respectively.

The outlook remains murky. Recent economic indicators suggest that the weakness continued into the third quarter, with the NAAMSA strike disrupting manufacturing output throughout July.

CUT

16 September 2014

Nedbank Capital Strategic Research

Mohammed Yaseen Nalla, CFA

+27 11 295 5430

MohammedN@Nedbankcapital.co.za

Reezwana Sumad

+27 11 294 1753

ReezwanaS@Nedbank.co.za

https://www.nedbankcapitalresearch.co.za

Nedbank Capital

Interest rate barometer | 16 September 2014 Page 2 of 4

Table 1 (continued)

Factors Outlook at July policy meeting Recent developments Rate impact

DOMESTIC ECONOMY

(40%) (Contd)

Domestic supply “The manufacturing sector performance in the first two months of the second quarter has also been disappointing, following the 4.4% contraction in the first quarter. The sector was negatively impacted by electricity supply constraints and the platinum sector strike, as well as the metalworkers strike. The Kagiso PMI registered a slight improvement in June, measuring 46.6 index points, but has remained below the neutral 50 index point level for three consecutive months.”

Mining production declined by 7.7% y/y in July, from -5.4% in June, much worse than expectations of -6.7%. The biggest contributors towards the contraction had been platinum, diamond and gold production, contributing a cumulative -13.6%.

Manufacturing production declined by 7.9% y/y in July, from growth of 0.2% in June, worse than expectations of -5.8%. This was the largest contraction since October 2009. The largest contractions came from the basic iron and steel sector, and the autos sector.

HOLD

Domestic demand

“Domestic motor vehicle sales declined by 2.3% on a year-on-year basis, but increased by 4.7% on a month-to-month basis in June. Despite these weak trends, consumer confidence surprised on the upside in the second quarter, with the FNB/BER consumer confidence index increasing from -6 to 4 index points, although respondents do not deem the present time as appropriate to buy durable goods.”

SA vehicle sales declined by 1.4% y/y in August, from a 1.5% decline in July, as passenger vehicles declined while commercial vehicles were higher. SA retail sales remained flat on an annualised basis in June, from a 2.6% increase in May. This was the weakest performance since December 2009, as households remained pressured by higher debt servicing costs, elevated unemployment and price pressures.

CUT

Monetary conditions

Growth over twelve months in total loans and advances to the private sector measured 8.2% in May 2014, but the divergent trends in bank credit extended to households and the corporate sector have continued. Growth in credit extended to the corporate sector has been steadily increasing since the beginning of the year, measuring 13.3% in May, due in part to renewable energy contracts. By contrast, growth in credit extended to the private sector has continued to trend downwards, to measure 4.3% in May.

Private sector credit extension growth accelerated to 9.8% y/y from 8.6% in June. Companies remained the main driver of credit demand (up by 1.4% m/m and 17% y/y), with the annual growth rate being the strongest since September 2008. Household debt to disposable incomes remains elevated, constraining their ability to take on more debt.

Overall credit is likely to remain subdued; maintaining a weak outlook for domestic demand, suggesting the absence of demand pull inflation is likely to persist.

HOLD

Forecast of inflation

“Inflation is now expected to average 6.3% in 2014, compared with 6.2% previously. The forecast for average inflation for 2015 increased to 5.9% from 5.8%, while the forecast for 2016 increased marginally to 5.6%, and to 5.5% in the final quarter of that year. Inflation is still expected to return to within the target band during the second quarter of 2015.”

Nedbank expects CPI at a level in line with the SARB, with an average of 6.3% forecast in 2014 and 6.0% in 2015.The forecast was downwardly revised from 6.4% previously expected for 2014.

HIKE

Market expectations

Forward rate agreements were pricing in a 51% probability of a 50bp rate hike at the last MPC meeting (or a 102% chance of a 25bps hike), an 89% chance of a 50bp rate hike in 3 months’ time, and a 137% probability of a rate hike in 6 months’ time.

Forward rate agreements are pricing in a 19% probability of a 50bp rate hike at this week’s MPC meeting (or a 38% chance of a 25bps hike), a 49% chance of a 50bp rate hike in 3 months’ time, and a 95% probability of a 50bp rate hike in 6 months’ time.

HOLD

INFLATION DRIVERS (40%)

Food prices “Food prices have been one of the main drivers of inflation since the beginning of the year and have generally surprised on the upside in recent months. There are, however, some tentative indications that we may be near the peak as maize and other grain prices declined. Apart from weather-related risks, the overall trend in food prices will remain highly sensitive to exchange rate developments.”

SA CPI moderated to 6.3% y/y in July, from 6.6% in June, beating both Nedbank and the consensus forecasts of 6.4%. The main reason for the slowdown in inflation came from transport inflation, which decreased to 6.9% y/y in July, from 8.6% previously.

Despite CPI food remaining unchanged at 8.8% y/y in July, food inflation is likely to ease in the coming months, supported by lower wheat (flat in August after falling 1.28% in July) and maize (-4.5% in August 2014) prices.

HOLD

Rand exchange rate

“The rand has largely decoupled from its emerging market peers, and depreciated relative to most currencies, as it reacted to deteriorating domestic fundamentals. The exchange rate of the rand continues to pose an upside risk to the inflation outlook. Since the previous meeting the rand has depreciated by 2,6 % on a trade-weighted basis.”

The rand weakened by 2.85% against the USD (and 1.12% on a trade-weighted basis) since the last MPC meeting, mainly due to a risk-off scenario currently being played out across EMs. Uncertainty regarding an earlier-than-expected Fed hike has been the major reason for the risk aversion. Outflows in the bond market have exacerbated the currency weakness across EMs and in SA.

HOLD

Administered prices

“Administered price inflation ticked back up to 8.9% y/y in May from 7.4%y/y in April and remained significantly above the 6% level with continued upside risk from higher electricity costs. CPI transport also ticked up to 8.9% y/y in May from 6.8% y/y in April. The petrol price was cut by 15c in May but is currently exhibiting a material under recovery as the rand weakened and oil prices rose.”

Administered price inflation fell to 7% y/y in August, from 8.6% in July, mainly on the back of lower transport costs as a result of the lower oil price. The petrol price was cut by 67-cents/litre in August, the biggest cut in 15 months.

Upside risks in the form of NERSA price hikes in 2015 could likely place some pressure on overall administered prices in the medium term.

HOLD

Wage settlements

“The trend in wage settlements pose an upside risk to the inflation outlook and these pressures are likely to intensify in the current difficult labour relations environment. According to Andrew Levy Employment Publications, the average wage settlement rate in collective bargaining agreements increased from 7.9% in the first quarter of 2014 to 8.1% in the second quarter.”

Wage settlements in excess of inflation threaten to reduce SA’s global competitiveness, should this not be met with productivity gains. Upcoming public sector wage negotiations could likely see wage increases in excess of CPI, placing further upside pressure on overall inflation

HIKE

Source: SARB, Nedbank

Table 2: Probability of outcomes

Impact Unweighted Probabilities Weighted probabilities

Global economy (20%) Cut 33% 7%

Hold 67% 13%

Hike 0% 0%

Domestic (40%) Cut 33% 13%

Hold 50% 20%

Hike 17% 7%

Inflation drivers (40%) Cut 0% 0%

Hold 75% 30%

Hike 25% 10%

Final Result Cut 23% 20%

Hold 62% 63%

Hike 15% 17%

Source: Nedbank

Nedbank Capital

Interest rate barometer | 16 September 2014 Page 3 of 4

UK and US start positioning for policy normalisation

EM policy response remains mixed among EMs

SA lags behind key EMs in terms of growth

SA PMI points to slower contraction in manufacturing output expected

FRAs price in 38% probability of a 25bp rate hike

Lower Brent price results in local petrol price cut

SARB policy dilemma persists

SA real repo rate remains accommodative despite hikes

Source: I-Net, Bloomberg, Stats SA, Nedbank

19%49%

93%

153%181%

243%

0%

50%

100%

150%

200%

250%

300%

1X4 3X6 6X9 9X12 12X15 18X21

FRA Market - Probabilities

Probability of 50bps move

Interest rate barometer | 16 September 2014 Page 4 of 4

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